It does little good for investors to dwell on large paper losses they might currently be witnessing, and in fact wise investors can take advantage of the occasion to derive valuable insights. We can point to two important lessons. With the markets in turmoil, the mettle of investors’ is being tested, and we continue to preach the virtues of firmly sticking to one’s allocation plan. A portfolio, after all, should be designed to accommodate one’s circumstances and tolerance for risk and it should be allocated without consideration for current market fluctuations or sentiment regarding the short-term direction the markets might take.
Nevertheless one’s risk tolerance can be very difficult to gauge accurately. For most investors the 1980s and 1990s offered no real opportunity to assess their ability to wait out a sustained bear market. If the recent market slide has genuinely prompted you to conclude that you have overestimated your ability to tolerate risk, you might adopt a more conservative portfolio (our recommended allocations are provided in the table below). In that rare circumstance, you should simply move to those new suggested allocations rather than trying to predict the “right time” to make the required changes.
To repeat: a portfolio change is warranted only if, upon introspection, you realize that your previous assessment of your personal tolerance for risk was inaccurate. If you are merely nervous about what might happen, join the crowd, but stay the course. Investors should also be wary of looking back. When faced with substantial losses, it can be tempting to allow the price you paid for an asset to influence your current investment decision. This is irrational. Except when realized gains or losses are an issue in taxable accounts, you should never allow your purchase cost to influence your decision to hold or to sell—no one else knows or cares about your cost. What you have paid for an asset is a sunk cost, and is irretrievable. Its future price will change only in response to new information, so the only relevant information you should consider is whether it still the optimal investment vehicle in an asset class appropriate for your circumstances, in light of alternative investment vehicles and asset classes that are available.
Also in This Issue:
Quarterly Review of Investment Policy
The Role of Gold
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
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